Private Equity Has Entered the 401(k): Who Is Actually Responsible for What?
Why private-market investments require fiduciaries to oversee the complete DC delivery chain
The debate over private-market investments within defined contribution plans was largely theoretical for the past few years. Are private-market investments a worthwhile addition to the diversification opportunity set? Can private investments provide DC participants with access to risk premiums traditionally available only to institutional investors? On the other hand, are the fees, illiquidity, valuation challenges, and overall complexity inherently unsuitable for participant-directed retirement plans? It is safe to say that the debate has moved from the theoretical into implementation.
In September, Constitution Capital Partners announced the launch of the Constitution Capital Horizon Collective Investment Trust with more than $50 million in initial assets across 18 retirement plans. The CIT is designed to provide private-equity exposure embedded within professionally managed DC retirement solutions.
This launch follows Principal Financial Group's earlier announcement that it is expanding its Featured Partner Program to support private-market strategies within retirement plans. Principal expects participating managers to develop CIT-based solutions combining public and private investments for use in target-date funds, target-risk funds, managed accounts, and other asset-allocation services.
These recent developments do not necessarily mean private equity will immediately become a common feature of 401(k) plans, but they do indicate that the operational infrastructure required to bring private-market strategies into defined contribution plans is being built and, in some cases, already being utilized.
The central governance question has therefore changed from whether private equity can be placed inside a 401(k) to whether fiduciaries understand the structure through which that exposure is delivered, the responsibilities assigned to each party, and the risks that can arise between them.
The participant sees one fund. The fiduciary oversees an ecosystem.
Private-market exposure is unlikely to appear in most plans as a standalone (e.g., designated) investment option that participants select directly, and I do not believe this will change absent additional future regulatory guidance. The most plausible - and currently most defensible - pathway for private investments into DC plans is through a diversified, professionally managed structure such as a target-date fund.
This preserves the outward appearance of simplicity from the participant's perspective. A participant selects, or, more likely, is defaulted into, a fund corresponding to an expected retirement date. The fund handles asset allocation, rebalancing, and changes in risk over time.
Beneath the outward simplicity of that single investment, however, may sit a network of organizations performing different functions:
· The plan sponsor and/or investment committee selects and monitors the target-date or other professionally managed solution.
· A bank or trust company maintains the CIT and may possess fiduciary authority over its management.
· An asset-allocation manager determines how much exposure the portfolio receives to public and private investments.
· A private-market manager selects and oversees the underlying private investments.
· A recordkeeper processes participant transactions and connects the investment structure to the plan's daily operations.
· One or more underlying funds hold the private assets.
· A valuation process translates periodically valued private investments into the daily unit value required in a participant-directed plan.
· A liquidity sleeve supports participant contributions, withdrawals, transfers, and distributions.
Depending on the structure, many or all of these roles may be necessary and reasonable if private assets are to be part of the retirement solution. That said, they collectively create a structure that is far more complex than the single fund name appearing on a participant statement. Therefore, the decision to embed private investments inside a target-date fund or other managed solution essentially transfers complexity from plan participants to the fiduciaries and providers responsible for designing, selecting, and monitoring that solution.
Delegation does not eliminate the need for oversight
Delegation can and should be part of sound governance. A professionally managed structure can appropriately allocate responsibilities to organizations with specialized expertise. A plan committee should not be expected to value individual private companies, manage capital calls, or determine the liquidity needs of a multi-manager portfolio.
Plan fiduciaries, however, must still understand what responsibilities they are assigning, whether the organizations receiving those responsibilities are qualified, whether potential conflicts have been identified and managed, and how the plan will monitor and assess their performance. It is unlikely that the titles of the various parties involved will be enough to answer those questions. The key determination is who actually possesses discretion or control over each important function.
Even where investment discretion has been properly assigned to another fiduciary, the appointing fiduciary generally retains responsibility for prudently selecting and monitoring that provider in accordance with the governing documents and the scope of the delegation.
The publicly disclosed Horizon structure illustrates this. SEI Trust Company serves as trustee and states that it retains ultimate fiduciary authority over the CIT's management and investments. Constitution Capital provides investment-related services but states that neither it nor its affiliates acts as an investment adviser or fiduciary to the CIT. The CIT, meanwhile, invests substantially all its assets in certain Constitution Capital-managed underlying perpetual funds.
The public disclosures do not provide enough information to evaluate the Horizon CIT itself, but they do illustrate the types of relationships and responsibilities fiduciaries must examine when evaluating any comparable structure.
That arrangement may be an entirely reasonable division of responsibilities, but it does elicit a series of additional questions that a plan fiduciary should be able to answer:
· Who selects and monitors the underlying funds?
· Who determines the private-equity allocation?
· Who can replace an underlying manager?
· Who approves valuations or valuation overrides?
· Who determines the size and composition of the liquidity sleeve?
· Who responds if participant transactions exceed expected liquidity?
· Who monitors the total cost across every layer?
· Which decisions remain with the plan fiduciary?
In short, delegation does not absolve a fiduciary from understanding (and appropriately documenting) the complete decision-making chain.
Daily pricing does not make the underlying assets liquid
Private-market CITs intended for defined contribution plans are usually described as daily valued or priced. That feature is critically important from an operational perspective, as plan participants expect to transact at a daily unit value for the investment. The issue is that daily pricing and daily liquidity are fundamentally different concepts.
Underlying private investments may still be valued less frequently, using manager estimates, appraisal processes, or financial information that becomes available with a lag. The resulting daily CIT value may therefore combine periodically updated private-asset valuations with more current values for publicly traded investments and cash.
Similarly, a liquidity sleeve may generally allow the CIT to accommodate ordinary participant activity without selling any underlying private assets. This sleeve's effectiveness, however, depends on several assumptions concerning participant and sponsor contribution flows, withdrawal activity, transfers between designated investment options in the plan, retirement distributions, market conditions, and the behavior of other investors in the CIT outside of the relevant DC plan.
Considering this, fiduciaries should model and understand how the managed solution containing the private-asset CIT and the CIT itself would respond to circumstances outside of "normal" expectations, and explore the additional questions that become relevant, including:
· How frequently are the underlying private assets valued?
· What valuation mechanism(s) are utilized?
· How are material events incorporated between formal valuation dates?
· Who can override or challenge a manager-supplied valuation? Is there an unaffiliated third-party assessment?
· How large is the liquidity sleeve, and what assumptions support that size?
· Has the structure been tested against simultaneous market declines and elevated participant withdrawals?
· What happens if the sleeve falls below its targeted level?
· Could valuation lags or liquidity-management practices transfer value between participants entering, remaining in, or leaving the fund?
· Are there circumstances in which transfers or redemptions could be delayed, gated, or restricted? How is this determined, and who makes the final decision?
Seeking an illiquidity premium while providing participants with daily liquidity is inherently challenging. The existence of a liquidity mechanism is not in itself evidence that liquidity risk has been resolved. The mechanism and its assumptions must be consistently evaluated.
Costs and performance require a look-through analysis
Private-market arrangements can also involve several layers of fees and compensation: trustee fees, asset-allocation fees, private-market management fees, underlying-fund expenses, performance-based compensation, recordkeeping charges, and the opportunity cost associated with maintaining liquid assets.
Fiduciaries should evaluate the total economic cost rather than focusing only on the stated expense of the top-level CIT or target-date fund. They should also determine which expenses are directly reported versus which are embedded in underlying valuations, and whether performance figures are presented before or after every relevant layer of fees.
Benchmarking presents a related challenge. Public-market indices may be transparent and inexpensive, but they may not capture the objectives, valuation practices, or liquidity characteristics of private investments. Private-market benchmarks may be more comparable in some respects while remaining subject to reporting lags, survivorship effects, or differences in investment vintage.
A prudent monitoring process should consider several reference points rather than a single benchmark. These might include public-market equivalents, private-market peer data, the strategy's stated objectives, vintage-adjusted results, liquidity experience, and the performance attribution of the private allocation and the assets maintained to support liquidity. The purpose is to determine whether the investment continues to perform the role for which it was selected and whether its costs and risks remain reasonable relative to that role.
Product availability is not fiduciary suitability
The Department of Labor's proposed framework for selecting designated investment alternatives focuses on six broad considerations: performance, fees, liquidity, valuation, benchmarking, and complexity. Those considerations are especially relevant to private-market investments, but they should not be treated as six discrete, independent boxes to check because they are interconnected attributes of the investment.
A liquidity sleeve affects expected performance and cost. Valuation practices affect reported volatility, risk-adjusted return measures, and benchmark comparisons. A multi-layered provider structure affects both fees and the committee's ability to monitor the investment. Recordkeeper dependence may affect investment portability and the plan's negotiating leverage. Participant demographics affect cash flows and therefore the appropriate private-market and liquidity-sleeve allocation.
The fact that a product has been engineered for daily operation, accepted by a recordkeeping platform, or structured as a bank-maintained CIT does not establish that it is or is not suitable for a particular plan. The fiduciary analysis must assess the product characteristics in accordance with the plan's participant population, objectives, cash-flow profile, governance capabilities, and the likelihood of improving participant retirement outcomes. Given this, a threshold question for many plan committees may be whether the committee has the information, expertise, and monitoring structure required to oversee the implementation being considered rather than the relative attractiveness of private equity as an asset class.
The governance standard should focus on the complete arrangement
Private equity may ultimately play a constructive role in some defined contribution plans, and professionally managed structures can provide diversification, manager selection, rebalancing, and liquidity management that individual participants could not reasonably perform themselves. Different plan fiduciaries overseeing different plans with different participant demographics and behaviors could, and likely should, come to different conclusions concerning the cost-benefit analysis of private-asset plan inclusion.
Accompanying this analysis should be the recognition that placing private equity inside a target-date fund does not transform it into an ordinary public-market investment, and that the delegation of responsibilities to specialized providers does not eliminate the fiduciary's obligation to understand and monitor the arrangement. Fiduciaries should be able to identify who controls each layer of the structure, how conflicts are managed, how valuations and liquidity are governed, what participants pay, how performance will be assessed, and, importantly, what happens when the arrangement does not operate as expected.
The most important question is no longer whether private equity can be placed inside a 401(k) plan. That debate is over, as it clearly can. The bigger question is whether plan fiduciaries can understand the complete delivery chain, evaluate the risks that arise between its different layers, and document why the entire arrangement is a prudent one for the participants of a particular plan.
